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Graphic: Mint
Graphic: Mint

BSE IT index gains most in 5 years, outpaces Sensex

Among IT stocks, TCS, Infosys, HCL Technologies and Tech Mahindra are up 20-53%, while Wipro is up 3%

Technology stocks have raced ahead of benchmark indices in 2018 after lagging them last year, as the Indian rupee weakens and the economic engines in the West roar back to life. An economic boom in developed nations implies greater outsourcing business for India’s information technology (IT) companies. Also, since these companies earn mostly in dollars, a weak rupee means greater revenues. The US economy grew 4.2% in the second quarter, while jobless claims hit a 49-year-low last week. Meanwhile, the rupee has slipped 11.51% against the dollar in 2018, touching a record low of 72.92 on Wednesday.

In the year so far, the BSE IT index has gained nearly 40%, outpacing gains in the benchmark Sensex index which has gained around 10%. In 2017, even as the Sensex rose 27.91%, the BSE IT index gained only 10.83%, as revenues grew slower at large IT services companies. This is the best performance of the BSE IT index in the last five years. In 2016, it had slipped 8%, gained 4.26% in 2015, was up 17.6% in 2014 and jumped 55.24% in 2013.

According to Arun Thukral, MD & CEO of Axis Securities, the improving US economy has changed sentiments toward IT sector, which draws a large chunk of its business from the US. “Better profitability of US companies (a part of which could come from tax cuts) would mean better business prospects for Indian IT services. Similarly, Europe is also limping back to stability following the economic revival of the financial crisis-hit peripheral economies. This improvement in the business prospects of Indian IT companies has led to the re-rating of the IT sector in general," he added.

Among IT stocks, Tata Consultancy Services Ltd, Infosys Ltd, HCL Technologies Ltd and Tech Mahindra Ltd are up 20-53% while Wipro Ltd is up 3%. 

Thukral believes Indian IT firms have witnessed a revival of growth on the back of increased technology investments from clients in the US and Europe. “But these investments are in newer areas such as digital and cloud at the cost of traditional outsourcing, where budgets are shrinking. Hence, we like Indian IT companies who are increasing their revenue share from digital and cloud business," he added.

According to a Kotak Institutional Equities note dated 10 September, a 1% rupee depreciation aids earnings before interest and taxes (EBIT) margin of IT firms by 20-30 basis points (bps) and net operating profit after tax (NOPAT) by 2-3%. It has upgraded FY2019-21 earnings per share (EPS) by 0-7% but slashed its US dollar revenue growth assumptions due to cross-currency headwinds, stating FY2019 EPS will be influenced by hedges, and all companies will receive an earnings boost in the subsequent year. 

According to Kotak, even though the rupee has weakened, its impact on immediate earnings will be decided by hedging. Kotak said Infosys has minuscule cash flow hedges of $300 million; TCS hedges but through options, meaning it will realize the benefit of rupee depreciation unless the company has entered into range barrier options with the rupee depreciating beyond the range; Mindtree hedges only the monetary assets and does not have any cash flow hedges; and Tech Mahindra has hedged 70-90% of net cash inflow over the next 12-months. Wipro, HCL Technologies, Mphasis and Hexaware, it said, have hedged aggressively. “Infosys, TCS and Mindtree do not have meaningful cash flow hedges and will benefit immediately from Indian rupee depreciation," the Kotak note said. 

According to a Motilal Oswal Securities Ltd report, a weak rupee boosts net profits and operating margins of the entire IT sector; however, the impact on individual company earnings will be determined by three aspects -- the share of dollar revenue among all currencies; the extent of onsite-offshore revenue mix that will determine the net exposure after natural hedge; and the hedging policy in terms of duration and proportion of the net exposures hedged.

However, it added that had the rupee weakened similarly against all currencies, the impact would have been felt on the majority of the revenues. In the calendar year so far, the rupee has fallen 11.51% against the dollar, 8.03% against the pound and only 8.27% against the euro. 

“Bottoming cyclical pressures and improved capital allocation are factors that will feed into the valuation multiples favourably. Currency keeps earnings growth ticking further," Motilal said in its note on 10 September. 

However, Nomura said Indian Tier 1 IT valuations are at a 20% premium to that of multinational corporations (MNCs) and 15-25% discount to Tier 2 IT and challengers. “Indian Tier-1 IT, after progressively showing lower market share gains over the past three years, has lost market share to MNCs. Also, FY19 guidance suggests a weaker year, with Cognizant and HCL Tech guiding for slower organic growth in FY19 versus FY18, Infosys likely to grow near the lower end of guidance (similar to FY18) and Wipro expected to grow low-single digits for FY19, on our estimates. The only exception is TCS, where we expect growth to accelerate in FY19," it said in a note on 6 September. 

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